We initiate a re-rating on Royal Orchid Hotels (ROHL) with a Strong Buy . Our rating underpins the company’s rapid expansion in the hospitality space, its rich property portfolio, new hotel launches and strong management bandwidth combined with asset light model.

Investment highlights

Diversified portfolio across categories and locations: The Company has 47 operational properties with a collective inventory of 3,269 rooms spread over 33 cities. The properties are spread across wide price categories ranging from 5-star to budget category rooms targeting leisure as well as business travelers. ROHL is all set to reach to 70-75 properties by the end of FY20.

Clear focus on management contracts implying asset light strategy:

The Company started its operations through the ownership model by setting up two hotels in Bangalore. However, over the past 3-4 years, it is increasingly focusing on expanding operations through management contracts and leasing rather than owning the properties. Under management contract, the company charges 2-3% of the revenue as management fees and an incentive fee which varies from 6%-8% of the gross operating profit. ROHL bears no expenses and even the onus of renovation of the property is on the property owner. Out of the 3,269 room keys, 2,292 rooms are under management contracts.

Reduction in GST rate to positively impact the Company:

Royal Orchid Hotels used to pay 21% tax under the pre-GST regime. The GST council has reduced the GST rate on restaurants and hotel stay (room rent up to INR7,500) from 28% to 18%. This move is expected to benefit the Company as a majority of Royal Orchid’s rooms fall under this bracket.

Demand-Supply mismatch:

Robust growth in the sector is awaiting since there is a demand-supply mismatch in terms of required room inventory. According to Ministry of Tourism, India is short of around 2lac tourist hotel rooms and India is projected to be the fastest growing nation in the wellness tourism sector. Tourist arrivals have been seeing a robust growth due to introduction of e-visa. It has already crossed 1 crore in CY2017. The drive to promote India as a tourist destination and increase in global growth has also led to larger travel to India by global tourists.

Deleveraging in the near future:

The Company owns two land parcels, one in Mumbai (Powai) and the other in Tanzania, which the management is planning to sell. The combined value of the properties is around INR90 crores. The proceeds from the above mentioned sale can be partially used to reduce debt further and the rest can be allocated for expansion plans.

Lemon Tree valuations:

According to various reports the market cap of Lemon Tree is expected to be aroundINR4800 crores on listing where as ROHL- Regenta having similar business model and more or less equal properties is having a market cap of around 510 crores .This leads us to the understanding that a re-rating of Royal Orchid Hotel Ltd is overdue. Comparing fruit to fruit, we expect there is a significant upside potential in the stock.